Trade Update – $QQQ: Spreading Feb Puts

by Dan January 5, 2015 2:56 pm • Commentary
On December 19th (below) we placed a bearish trade in the Nasdaq 100 (QQQ) with the intention to sell some premium on a short dated basis in an effort to help finance the purchase of some longer dated put premium. Essentially fading the year end bounce and playing for an early 2015 decline.  The short put portion of the calendar expired last week and we are now naked long the February 101 puts. Here was the original trade structure:
TRADE – Buy the QQQ ($104.40) Dec 31st quarterly/Feb regular 101 put calendar for 1.45

– Sell to open 1 Dec31st 101 put at .25

– Buy to open 1 Feb 101 put for 1.70

With the QQQ’s now at at $101.25 (very near our long pur strike) the Feb 101 puts are trading 2.55 (our cost is 1.45) and it makes sense to add back a short portion of the structure after such a sharp short term decline:

ACTION – versus 1 QQQ ($101.25) Feb 101 put sell 1 Feb 95 put at 1.05 to open
New Position – Long the QQQ Feb 101/95 put spread for 40 cents

Break-even on February expiration: 

-Gains of up to 5.60 between 100.60 and 95.00 with max gain of 5.60 at or below 95

-Losses of up to 40 cents above 101 with max loss of 40 cents above 101

Rationale:  The 200 day moving average is just below $96 , a level that would mark nearly a 10% decline from the high made in late November.  We think in the near term that is a reasonable level to cap gains as the sale of the Feb 95 put significantly reduces the premium at risk.  If you have done this sort of trade as a hedge against a portfolio of longs then it could make sense to wait for more declines and sell a lower strike put to get ore potential protection.
original post:

Despite the recent bout of volatility across almost every major risk asset in the world, it has been my view that U.S. equities were likely to close at or near the highs for the year, largely due to the fact that about half of fund managers are lagging their benchmarks by about 2.5% ytd.  Put another way, there was bound to be a performance chase, and the Fed’s mid week rate announcement was just the excuse needed to mark stocks up into year end, especially as our markets has been marked down by external factors like crashing oil, fears of a credit contagion emanating from Russia, and a general economic malaise plaguing most emerging markets.

It has also been my view that U.S. equities could see downward volatility as global growth fears weigh on growth prospects for U.S. stocks at a time that the Fed is basically out of the game.  I am very much in favor of the idea of playing for a Q1 correction and possibly a meaningful one if oil continues to its deflationary decline at a time when U.S. multi-nationals contend with a stronger dollar and exposure to emerging markets.

For the time being I want to focus on technology stocks, specifically the Nasdaq 100 (QQQ). It has a heavy concentration among a handful of names that, in my mind, have displayed waning momentum.  AAPL, BABA (which is not in the Nasdaq 100, but would be in the top five by market weight) and GOOG have recently been subject to profit taking and showed somewhat weak bounces on a relative basis in the latter half of this week. My sense is that we could see a continuation of this selling in the new year, especially if there is a shred of disappointing fundamental news on the earnings front in January and February.

With that in mind, the explosion in equities the last few days could be a gift for those who think early 2015 could be a rocky period for equities and that the fears that plagued us last week will rise again. That, coupled with the potential earnings headwind of a strong dollar and weak emerging markets means this bounce offers the potential to take profits, hedge existing holdings or make outright bearish bets.

BUT. With the holiday weeks fast approaching, and the potential for low volume quiet market activity, it makes sense to finance the purchase of premium by selling shorter dated options and buy longer dated ones:

TRADE – Buy the QQQ ($104.40) Dec 31st quarterly/Feb regular 101 put calendar for 1.45

– Sell to open 1 Dec31st 101 put at .25

– Buy to open 1 Feb 101 put for 1.70

Break-even on Dec 31st quarterly expiration – This trade does best if the QQQ trades sideways or slightly down into year end. A rally higher into year end would mean losses but they shouldn’t be too bad as Feb won’t decay too rapidly. Once Dec expires I’ll look to roll the short put portion of the trade reducing my break-even and lessening my risk.  The max risk is 1.45, with max loss with a dramatic move above or below $101.

Rationale – this structure fades a QQQ sell-off by year end, just above the recent lows with the sale of the Dec 31st puts in order to finance what could a play for what could be an early year pullback from recent highs in the broader market. We don’t think the problems that hit the market last week are going away anytime soon and after the holidays and year end positioning it makes sense that the market could see some action in the early months of 2015. It’s entirely possible that that first move is higher in early Jan, so that’s why we like selling the Dec 31st puts to finance Feb. When that expires we’ll have the chance to roll the short put to either Jan or Feb in order to have the bearish bet on for as little risk as possible.

This structure could also work as a hedge against a portfolio but it’s not a pure hedge until after the New Year as there is that chance that we return to selling before year end. We don’t think that’s that likely, but it is possible if oil selling continues or emerging market fears flare up again soon.

Technically, the ytd chart below shows the importance of the $101 breakout level from early November, after an already dramatic 10% bounce off of the mid October lows:

QQQ ytd chart from Bloomberg
QQQ ytd chart from Bloomberg